The Reserve Bank of India (RBI), in its sixth bi-monthly policy statement for the year on February 8, 2017, may have to delay the reporate cut until a better picture emerges out of the remonetisation exercise. Thanks to demonetisation, the banks are already flush with funds and any rate cut may not deliver the desired results.

According to a recent Citigroup report, "The remonetisation exercise may hold the rate cut back as it is expected to be more effective after the remonetisation exercise is concluded fully and there is absolute clarity on the increase in lendable resources for the banks."

What needs to be deciphered is how much of these funds will remain within the banking system, which should help the banks and the regulator to take a better call on interest rate.

Recently, Economic Affairs Secretary Shaktikanta Das had said, "The exercise of remonetisation that began after scrapping of the old Rs 500 and 1,000 notes on November 8 is "nearly complete" as practically there are no restrictions on withdrawals." He added, "I am using the word near-complete because this Rs 24,000 limit is there." The central bank will keep reviewing the weekly limit in the near future, depending on the pace of remonetisation.

On the other hand, in continuation of its earlier policy stance and also to provide a boost to the demonetisation-hit gross domestic product (GDP), the RBI may go for a cut in the repo rate. A repo rate (the rate at which the banks borrow from the RBI) cut will help the banks lower their cost of funds and provide credit at a lower rate, thus bringing in a benign interest rate environment for corporate and retail borrowers.

InflationIn a low interest rate environment, with cash easily available, the risk of the inflation rate going up exists. Hence, unless the RBI is convinced that the inflation is under control, the magnitude and timing of the rate cut will be impacted. Recent data shows that retail inflation rose for the fifth straight month in December 2016, touching 5.61 per cent on the back of higher vegetable and cereal prices. Even the global oil prices are firming up.

Government borrowings signal lower interest rate regimeTo meet a portion of its expenses, the government borrows from the market by issuing dated government securities. And in doing so, it squeezes liquidity from the market, thus putting pressure on the interest rate. So when the government announces that it will limit its borrowing programme for the year, it signals a lower interest rate regime.

Such a signal was there in Budget 2017 when the Finance Minister Arun Jaitley announced limiting the net market borrowing of the government to Rs 3.48 lakh crore, much lower than Rs 4.25 lakh crore of the previous year.

Irrespective of what the central bank does tomorrow (Wednesday), the existing borrowers with Marginal Cost of Funds based Lending Rate (MCLR) loans and those who have already locked their funds in fixed deposits (FDs) will not be immediately affected. Only new borrowers and those looking to put money in FDs going forward will be impacted by a rate cut, if any.

Impact on MCLRWhether or not the RBI cuts rates, the banking sector's lending rates are already coming down. The bulk of the demonetisation funds is lying in current and savings accounts (CASA) of banks, of which interest rate (4 per cent and thereabout) is paid to the account holders of only savings accounts and not on current accounts. This has led to the lowering of cost of funds of the banks and, therefore, MCLR has come down.

Any repo rate cut will further induce banks to lower their lending rates, including home loan rates.Currently, the 12-month MCLR for most banks is about 8.75 per cent. After the mark-up (spread or bank margin), the actual home loan rate, could be higher.

All bank loans, including home loans, taken after April 1, 2016, are now linked to the bank's MCLR with or without a spread (bank margin). Earlier, they were linked to the bank's base rate.

Impact on base rateAny repo rate cut may not make the banks pass on the benefit to the borrowers as has been seen in the past.

In the base rate regime, the banks were either reluctant to cut their lending rates (post RBI repo rate cuts) or did so with a time lag. Since last year, when the MCLR came down by almost 1 per cent, the base rate for most banks have either moved marginally by about 0.25 per cent or not moved at all.

For existing borrowers, who had taken loans after July 1, 2010 but before April 1, 2016, the loans are linked to the bank's base rate. And, for most of them, the home loan interest rate is upwards 10 per cent.

ConclusionIf at all the RBI goes for a rate cut now, its magnitude could be less. Going ahead, with more clarity on the global front and especially on remonetisation, one may expect a larger rate cut. Home loan borrowers, who are serving their loans on base rate, should switch to existing or another bank's MCLR, unless their loan is nearing maturity. For new borrowers, the next few months could turn out to be a bonanza.

Subscribe ETCFO Newsletter

They can also be a key intermediary between businesses in the shadow economy and those in the formal economy helping firms to manage their affairs, legalise and “come out of the shadows” says Director of Professional Insights, ACCA, Maggie McGhee.

Robin Banerjee, Managing Director and Executive Director, Caprihans India Ltd, a subsidiary of Bilcare Ltd and author of the book, Who Cheats and How? Scams, Frauds and the Dark Side of the Corporate World, talks to ET CFO about the best fraud management practices and the CFO’s role in these.